Ohio takes another swing at severance tax legislation

The oil and gas industry in Ohio finally appears to have found a piece of severance tax legislation it likes, though it might have had to write a fair amount of it itself to get there.

Now comes the real test — getting it through the Legislature and to the governor's desk if not intact, at least in a recognizable form with the same provisions that the industry now says it will support.

Not that Ohio Oil and Gas Association is not expecting some changes.

“There are 132 legislators who will have some thoughts on what should be incorporated into the proposal, so it's hard to say what will actually come out in the end,” said Penny Seipel, vice president of public affairs for the association.

The proposed package, as currently written, would revamp severance taxes on oil and gas production by horizontal shale drillers, while reducing taxes for the state's traditional home-grown drillers, who typically drill smaller vertical wells into sandstone formations.

Taxes on shale gas and oil would change from their current levels of 20 cents per barrel of oil and 3 cents per thousand cubic feet (mcf) of natural gas to a flat 1% tax on all gross receipts from the sale of gas, oil or natural gas liquids such as propane and butane. At current prices, that 1% tax would work out to be about $1 per barrel of oil and about the same 3 cents per mcf of gas.

Then, after a well is in production for five years, the tax would double, to 2% of gross receipts. That increase might be the sticking point for lawmakers, because such a scenario might amount to no tax increase at all for drillers, at least when it comes to natural gas. Judged by other shale plays, it would allow them to get most of the gas out of a well long before the tax rate doubled after five years.

Wells lose their fizz

That's because shale gas wells are sort of like pop bottles that have been shaken and then cracked open. The pressure is the greatest right after a well is opened, and that's when the production is highest as well. After the first year, production volumes already have dropped for many shale wells, and continue to drop as time passes.

Speaking at a shale gas conference held by his organization Dec. 5, OOGA vice president of operations and geologist Peter MacKenzie declined to speculate on how much production would decline over a five-year period for the typical Utica shale gas well.

“It's too soon to say,” Mr. MacKenzie said, when asked about the matter.

Other shale plays indicate the drop could be fast and steep.

A 2011 report by officials at the oilfield service giant Schlumberger found that wells in the Barnett, Fayetteville and Haynesville shale plays all saw their production drop by more than 50% after just one year of production. After five years, the wells' production had dropped by 80% or more in those plays, the Schlumberger report found.

Then there's the matter of favoring conventional drillers over horizontal drillers.

Since the Utica formation first came on the scene, drilling proponents have argued that shale gas drilling is cleaner and safer than conventional drilling — largely because more gas can be brought up by a single well and also because shale drillers are larger, more sophisticated and more closely monitored. It also has been found, by researchers at Kent State University, that horizontal shale gas wells use less water for every mcf of gas that they produce than do conventional wells.

Why, then, promote conventional drilling with an advantageous tax structure? Because OOGA was able to get consensus among its members with that setup, Ms. Seipel said.

“We were able to approach our members and ask their thoughts, both conventional producers and shale producers, and the members that were contacted were comfortable with the tax proposal as a package,” Ms. Seipel said.

Is part of a loaf better than none?

OOGA also appears to have gotten some backing from Gov. John Kasich and some cautious support from environmental groups; both had been pushing for higher taxes on oil and gas since the shale boom came to Ohio.

Gov. Kasich had wanted to raise oil and gas taxes to help fund a reduction in state income taxes. The new proposal backed by OOGA would bring in less money to do so — about $1.7 billion over 10 years, instead of the $2.8 billion the governor wanted — and would earmark some of the money for other purposes. Some of the revenue would pay for state geological services the oil and gas industry uses, some would be used to manage old abandoned wells, and there would be specific income tax credits for landowners and other royalty payment recipients who paid the severance tax.

Nonetheless, a smaller tax take is better than shelving the severance tax issue altogether in the eyes of some.

“Give the Ohio House Republicans credit for proposing a severance tax increase,” said Jack Shaner, senior director of legislative and public affairs for the Ohio Environmental Council. “Unlike the Kasich administration's proposal which only funded personal income tax relief, the House proposal is right to make regulatory oversight and orphan well plugging top priorities for resultant revenue.”

“Plus, the House proposal includes new tax breaks and tax credits for the industry,” Mr. Shaner said. “The bottom line question for Ohio is: How much revenue will result and will it be sufficient to fund adequate state oversight of this growing industry?"

Gov. Kasich might not have had much choice in the matter. One Statehouse source, who asked not to be identified, said the proposed legislation was written largely by OOGA before it was sponsored by Ohio House Speaker William Batchelder and Rep. Matt Huffman. Neither the Kasich administration nor the American Petroleum Institute, which typically represents larger drillers, had input into the new proposal, the source said.

Ms. Seipel said she did not know if the governor's office was involved in drafting the legislation and declined to say how much of it had been authored by OOGA or its attorneys.

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